China sneezes and the world coughs

The Canberra Times

Nothing summed up the primacy of the United States economy in the 20th century better than the old phrase "when America sneezes, the rest of the world catches cold". Now it is China's sniffles, exemplified by plunging stock markets, repeated suspensions in share trading, and a declining yuan which are threatening global contagion.

The turbulence on Shanghai's stock market last week has triggered selling on bourses around the world, and nowhere have the bears been more active than in Australia. The ASX began 2016 with its biggest weekly fall in more than four years, and the Australian dollar posted a similarly dismal start to the year, falling below US70¢ last Friday. BHP, Rio Tinto and other Australian miners were among the stocks hardest hit, reflecting concern, in part, about China's slowing rate of economic growth and its pivot away from an investment-led exporter of manufactures to a consumption and service-based economy.

Commentary on the significance of China's share and currency tremors is divided. Some believe the markets over-reacted, and that China's economic fundamentals remain sound. Others, like former US treasury secretary Lawrence Summers, say that because of China's "scale, potential volatility and … limited room for conventional monetary manouevres, the global risk to domestic economic performance in the US, Europe and many emerging markets is a great as any time I can remember". Hedge fund manager George Soros says the financial markets' serious challenge reminds him of the "crisis we had in 2008".

China's shift to a more conventional economic model has certainly challenged its policy-makers and financial regulators. Where once China posted annual rates of economic growth well into double figures, this has slowed to about 6-7 per cent. Rising wage costs have eroded export competitiveness and led to official attempts to drive down the yuan – efforts which succeeded only in adding to market apprehension. Stock market and property speculation has helped push Chinese debt levels to extraordinary levels, and currency reserves have been depleted by people moving their money overseas – signs, some suggest, of a loss of confidence in the government's inability to handle the economy proficiently.

If China's attempts to rebalance investment and consumption have led to reduced imports of raw materials, excess industrial capacity, and falling profits, the country's middle class is expanding rapidly. Consumer markets are maturing, in line with rising per capita income, and investment in high technology industries, and in commercial services, is rising. Once rebalancing is complete, there is reason to expect that China's economy will be stronger than ever.

But first, China's government needs to attend to the matter at the heart of the current turmoil – its inclination to react to falling stock markets by hastily conceived policy responses such as shutting down the Shanghai bourse for 15 minutes at a time if the composite index rises or falls by 5 per cent. Far from engendering, stability this has only fuelled selling pressure. It's one of a number of crude policies which is fundamentally at odds with China's aspirations for its economy to be integrated with the world.